Crypto Bust

Bobby was the lead guitarist of two bands that were huge in the 70s. He still plays with one of them but touring is largely confined to Germany and the Far East now, the only places where there is still a well paying audience for the old songs. Bobby’s adviser before me (1990s) drove a motorbike to their meetings and would sometimes bring one of his guns from his collection to show off. Bobby’s adviser invested his clients’ money according to his own attitude to risk and not his clients’ (we wrote about this tendency here) and this was how Bobby found himself invested in a Technology ISA in 1999. Needless to say he lost 60%+ of this money in the Tech Crash of 2000-2003.

There was huge pressure from clients to recommend Tech funds in the late 1990s, a week wouldn’t go past without someone phoning to ask for one as they had overheard someone in the local pub talking about how well they were doing with theirs. For the recent generation that think that they invented FOMO (fear of missing out), be assured that it has been with us since the dawn of time.

I have always been unfashionably cautious about any latest fad and so was disturbed when a cabinet maker took time away from the job he was doing for me late last year, to talk to me about his ‘diverse portfolio’ of 5 crypto-currencies (crypto). Even more alarmingly, the same week, I saw comments from a few younger advisers saying that cryptos should play a part in client portfolios.

It is not as though I haven’t tried to understand cryptos, it’s just that every time I try to calculate the value of one, I get zero as the result. If you want to work out a price for a stock or bond you can multiple the income (dividends or interest) that is on offer by the multiple that you are happy to pay. The only exception to this rule is a commodity such as Gold where there is no income and the value is simply as a ‘safe’ store of value when other prices are falling. Gold has been described, more than once, as shiny and useless (not quite true as it has a use in electronics as a conductor).

The problem with cryptos, is that all the hype and criticism surrounding it hides the more important debate; are they actually worth anything? Warren Buffett, for one, seems to think that they aren’t. The value of a currency is driven by six factors: scarcity, divisibility, acceptability, portability, durability and uniformity. Bitcoin is the largest of the cryptos and scores well for scarcity, divisibility and uniformity (hard to counterfeit) but its value is being driven by its scarcity and speculation. What it lacks is acceptability which is driven in turn by utility (usefulness) which is crucial to it having any value beyond speculation.

For a new technology Bitcoin is actually a worse payment system than the existing ones that we have. Its decentralised nature means that paying for something with a Bitcoin rather than your Visacard is much slower (4 transactions/sec vs 6,527 transactions/sec) and much more expensive ($7.50 per transaction). Speed + cost have and will continue to fall but without a use-case currently there remains little underlying value in Bitcoin. Mining a single Bitcoin is reckoned by JPMorgan to cost $13,000 but it has been much higher in the past and therefore is the price of Bitcoin continues to fall it might become uneconomic to mine them (unless mining costs also fall).

Bitcoin mining is also a constraint on its future value as it is so energy intensive that just the mining for this one crypto is estimated at 150 terawatt-hours of electricity, which is more than the entire country of Argentina. Future climate change legislation (and rising energy prices) might therefore add significant costs onto miners. On some measures Bitcoin mining has undone all of the good work of our global transition to renewable energy. Tesla alone might have wiped out the climate gains from its manufacture of electric vehicles by buying $1.5billion of Bitcoin in 2021 (it has now sold off most of this).

So if Bitcoin has a questionable value why is the price still at $22,000 (still hugely down from the November 2021 peak of $69,000)? Well the first thing to understand about the crypto ecosystem is that, despite its extreme Libertarian roots, it is a much less democratic system than main markets. Stockmarket ownership is concentrated, with the top 1% of US investors owning 53% of the total US stockmarket. By contrast the top 0.01% of crypto holders own 30% of all crypto. The crypto bros are actually a small number of individuals who own a huge part of the market with lots of interlinking structures. In recent months there is evidence that some of these individuals are moving money around with the deliberate aim of supporting the price of Bitcoin, which is the largest by a long way of the cryptos.

This small number of individuals have made huge amounts of money on paper and they need to cash out at some point. That has been the aim of the last two years when cryptos have been hugely marketed to ordinary investors, to bring new people and their cash into this speculative bubble. Most cryptos work on the greater fool theory – the theory that it doesn’t matter what price you pay for an asset because you will be able to sell at a higher price to a greater fool in the future. The greater fools that have entered this market in the last two years have lost substantial amounts of money. This money hasn’t evaporated, it has gone to the original small group of owners in the crypto world.

We have been talking about the biggest of the coins so far but there are also, by some estimates, 12,000 others. There is no good reason for this many cryptos and it is likely that most of these have been set-up deliberately to scam people out of money. This is done through pump and dump schemes (where a few individuals bid the price up and then exit when new investors are attracted in by the fake past returns) or rug pulls (where a new coin project is promoted and then the original issuers pull out, taking the money with them).

In a shocking recent example, crypto broker Voyager in the US was claiming that their clients were protected by the Federal Deposit Insurance Corporation when they weren’t. Voyager has now filed for Chapter 11 bankruptcy and their customers stand to lose billions of dollars. If you read the online comments it is clear that Voyager sucked in lots of ordinary people who thought the FDIC insurance protected their deposits. Voyager were offering annual returns of 8%-10% which should have been a red flag to clients but is actually a low rate compared with some of the ridiculous returns promised in this space. Part of the problem for Voyager was a huge loan it made to 3Arrows Capital, a crypto hedge fund, that itself went into liquidation in the recent crash. This is a good example of how inter-linked some of these companies can be and how contagion can spread.

There is so much money being lost in the sector at the moment that there is a website devoted to news of constant crypto issues. It is well worth a read to understand some of the craziness going on.

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